Read an Excerpt
Don't Let Your Clients Eat Dog Food When They're Old!
A Financial Professional's Guide to Retirement Cash Flow Management
By Roger Roemmich iUniverse
Copyright © 2014 Roger Roemmich
All rights reserved.
ISBN: 978-1-4917-4371-3
CHAPTER 1
Missteps and Blunders Common Client Mistakes
You can be young without money, but you can't be old without it. —Tennessee Williams
At the risk of sounding arrogant, I have to say that sometimes our clients are their own worst enemies. They mean well, naturally. They want what's best for them and their loved ones. They crave the ability to live life in retirement without financial worries, but they often make mistakes leading up to retirement and in retirement that tilt the odds against them. In a sense, we have to save them from themselves. Just as important, it's essential for us to know which life ring to offer when the financial waters get rough. To do that requires us to look at how we serve our clients in ways that differ greatly from those of the past. We can't stick to what we've always done. We have to look carefully at our own practices to avoid giving advice that can end up hurting the people we are striving to help.
That's easier said than done in many cases. It's human nature to stick to the familiar path that offers the course of least resistance. The familiar is comfortable. It's what we know, and it's also often the cause of real harm when it comes to the formulation of an integrated plan to assist our clients in their efforts to accumulate sufficient wealth to retire. In the years subsequent to retirement, the familiar emphasis on asset retention without giving due consideration to retirement cash flow is a common misstep.
Likewise, failing to fully include tax considerations in the cash flow package can lead to unpleasant financial consequences. The intricacies of Medicare and long-term care are all part of the puzzle as well. Of course, I'll discuss professional insights in the coming chapters, but let's start out with the typical blunders clients frequently make before and during retirement. If you know the nature of the missteps, you can help your clients avoid stepping on a financial landmine or two.
The most common client blunders
Blunder 1: Retiring too early
The single worst mistake your clients can make is leaving their jobs too early. Typically, your clients are at the peak in terms of earnings toward the end of their careers. That means they can maximize their contributions to qualified retirement vehicles—traditional individual retirement accounts and 401(k) accounts, or they may contribute to Roth IRAs (in lieu of traditional IRA contributions). Contributing to traditional IRAs and 401(k)s eliminates taxes on capital gains and other forms of growth on the investments. Some financial advisors recommend against maximum contributions in favor of reducing debt on home mortgages, which is a bad idea. If you don't recommend that clients make the maximum contributions that they can afford, especially in the end years of their working lives, you're not pushing clients toward an opportunity to truly leverage their assets for long-term cash flow during retirement. Similarly, the Roth IRA is often ignored when it shouldn't be.
When your clients say they want to quit work, they're also likely going to say they want to collect Social Security before reaching full retirement Don't Let Your Clients Eat Dog Food When They're Old! | 3 age. That's sixty-six for boomers born before 1960, and it's sixty-seven for boomers and younger people born in 1960 and beyond. Most of us fully understand that is a mistake because it substantially decreases benefits. Retiring at sixty-two instead of sixty-six will cost clients born between 1943 and 1954 a whopping 25 percent of their benefits for life! With life expectancies now firmly trending to the mideighties for men and women, at least according to some insurance company actuarial tables, the long-term cash flow benefits of Social Security represent the most valuable lynchpin in a retirement package for most clients, especially those on the verge of retiring.
Urge your clients to defer Social Security for as long as possible! For example, if they defer until they're seventy, they'll earn an 8 percent bonus per year after age sixty-six for boomers born between 1943 and 1954 on top of the benefits they'd receive at full retirement age. Over time, that really adds up! In later chapters, we'll talk about spousal benefits and bonus deferment benefits if clients put off collecting until age seventy. We'll also talk about paying back Social Security benefits and why that can be a smart move for some people if they do so within twelve months of beginning to collect benefits.
Blunder 2: Retiring with too much debt
It comes as no surprise that most Americans have debt. What does surprise financial professionals is how many people want to retire while they're still carrying debt on homes, boats, cars, and high-interest credit cards. Clients may also have to pay for alimony, the care of an elderly parent, or even college tuition for their kids. Debt should be viewed in arbitrage terms. Is repayment a better after-tax use of assets than making an investment when capital gains are factored into the decision?
Generally speaking, clients should have no debt other than a low-interest mortgage of 5 percent or less. Selling investments to pay off high-interest debt nets a gain far in excess of the returns on most traditional investments today. Yet, some financial professionals advise clients to keep the investments anyway. I've never been able to figure out the logic of that, but life is often quite illogical, so I guess nothing should really surprise me.
The problem may arise from the fact that many clients and some financial advisors focus almost exclusively on capital retention. Keeping the pile of gold intact becomes almost an obsession. Thus, the idea of selling a stock to pay off high-interest debt sounds counterintuitive, as does the idea of securing a low-interest home equity loan to do the same thing. Of course, it isn't! Also counterintuitive is the inclination to prepay the mortgage, but the higher return from leveraging the capital with proper investments is a better use of the assets. Essentially, the entire debt-to-asset ratio comes into play. Few clients really understand how it all works and how debt can seriously reduce total cash flow. It's up to us to explain it all in simple terms the average Joe can understand.
Blunder 3: Failing to prepare for maximized cash flow during retirement
Asset accumulation and retention is often the Holy Grail of clients and financial advisors. However, cash flow is really the key consideration before and after retirement, not asset accumulation and retention. For example, if the client has a pension, that pension has value for cash flow, but a surprising number of clients don't view it as a valuable asset because it's an intangible until they start collecting. Social Security falls into this category as well. Yet, from a cash flow perspective, the one in five Americans who still have some kind of pension are truly in the catbird's seat!
If the client has an annuity, the value of that product is in its ability to deliver cash flow for the client for life, and with life expectancies trending ever upward, the annuity could provide a key leg of the proverbial financial stool. Clients may balk at the notion of sinking $100,000 into an annuity that promises only $5,000, or 5 percent, in returns per year, thinking that it would be better to simply leverage the assets instead. What the client doesn't understand is that the right variable annuity can offer a basket of benefits in addition to the 5 percent annual lifetime guaranteed payment.
Financial professionals often under-appreciate the advantages of tax-deferred annuities with living benefits, such as the ability of the client to access payouts for long-term care costs in the event that the client is no longer able to complete two of the six designated activities of daily living. Diversified dividend-paying stocks, short- and midterm bonds, and dividends from alternative investments, such as a real estate investment trust, are other buckets clients can put in place for enhanced retirement cash flow.
Your clients may think they need less cash flow to pay expenses when they retire, but, in my view, they actually need cash flow for 100 percent of their current expenses. Tax savings do provide a part of cash flow after retirement for most clients. Some industry experts say they'll need only about 70 to 80 percent of their current cash flow. I disagree. Retirees need to have positive cash flow with a built-in safety buffer to protect against the inevitable unforeseen bumps in the road and to fight off the erosive impact of creeping inflation.
Although some may say it's self-serving, it's important for you to steer your clients toward investing their money in sound and stable financial instruments. A steady blue-chip stock that pays a reliable 3 to 4 percent dividend is well worth a look, as opposed to taking a flier in the tech or pharmaceutical segments of the market on stocks that go up and down like a yoyo whenever the wind shifts on Wall Street. If your clients aren't invested, they'll never make their money grow beyond the pressures of inflation, even those of ordinary times. We're not living in ordinary circumstances, not since 2008 when the world's economy changed dramatically from what it once was.
Blunder 4: Not making maximum contributions to tax-deferred accounts before retiring
Many clients, especially those nearing retirement, will want to siphon discretionary funds away from contributions to tax-deferred accounts like an IRA or a 401(k) when in fact those years just prior to retirement are important ones for this type of contribution. Some clients and financial professionals may argue that the taxes will have to be paid later anyway, so it makes little sense to defer now because you'll have to pay the piper at some point. However, with the right basket of investments, it's possible to defer the taxes until the bracket is reduced from a client's peak earning years. Drawing down a Roth IRA first is a good example of how clients can put off paying the taxes on qualified retirement accounts for as long as possible. Without you to help them, clients might draw down a traditional IRA before they draw down a Roth IRA. Or, worse, they'll reinvest in a low-interest taxable certificate of deposit while taking distributions from a 401(k). The point is the retiree will need to have maximized all tax-deferred income for as long as possible during the accumulation phase to enable implementation of cash flow strategies that minimize tax liabilities during retirement.
Blunder 5: Ignoring taxes on investments and Social Security before and after retiring
It's very common for clients to put blinders on when it comes to various tax issues, such as income taxed as ordinary versus capital gains. It's also very common for financial professionals to make the false assumption that retirement tax issues parallel tax issues during a working career. They don't. Thus, the tax situation can get out of hand very fast. Tax treatment of investments becomes the second great discriminating factor for the quality of retirement life. Most financial professionals fail to recognize that net cash flow after taxes and protecting net cash flow after taxes are the two most important financial variables in the financial quality of retirement life.
For example, your clients are not likely going to fully understand the taxability issues surrounding their Social Security benefits, and yet protecting those benefits from as much tax as possible is an essential key to bolstering retirement cash flow. Finding ways to keep the modified adjusted gross income levels below the tax threshold through distributions from Roth IRAs, reverse mortgages, and partial or full distributions from fixed or variable annuities with values below their tax cost are highly advantageous for clients. So are home equity loans in some cases, especially in earlier years of retirement when deferment of Social Security benefits, annuity withdrawals, and distributions from tax-deferred accounts can add up to big bucks later.
Blunder 6: Not including long-term care protection in retirement strategies
Long-term care is a very touchy subject for nearly all of us. We detest the idea of living out the last of our days in some hellhole of a nursing home. Incontinence, bedsores, terrible food, physical frailty, Alzheimer's disease, lack of mobility, it all comes together to create a depressing nightmare of old age that's easier to ignore than face head on. Your clients are very likely to scurry away from a discussion about long-term care protection, and it will be up to you to gently steer them to some of the stark realities they need to take into account as they plan for their retirement.
According to the American Association of Long-Term Care Insurance, in the next twenty-five years or so the number of seniors with disabilities, many of which will make them candidates for long-term care, is projected to double, impacting about twenty-one million of us. One out of four retirees will likely require some form of long-term care during their retirement years, and that's a conservative estimate. Other sources put the figure at closer to 70 percent of all retirees over the age of sixty-five. Rest assured, though, when you bring up the subject of long-term care, your clients are likely going to say they don't need protection.
Tell them to guess again! Unexpected long-term care costs are the leading cause of poverty among senior citizens who were otherwise able to make ends meet. Long-term care in a skilled-nursing setting, like a nursing home, averages a little over $72,000 per year, says the US Department of Health and Human Services. The numbers from the 2012 Genworth Cost of Care Survey puts the figure at $81,030. In metropolitan areas, the costs can soar to the low six figures without batting an eye. Millionaires on my client list would be hard pressed to keep up with these costs for any length of time. Sadly, long-term care lasts a year or two in most cases, and sometimes the patient lingers on far longer than that. In short, individuals can't afford to pay the costs, and many can't afford to pay the costs for protection either.
We'll take a close look at the various options available today, including traditional long-term care insurance and annuities and universal life insurance that build long-term protection into the package, usually for an extra fee. Even partial coverage is better than no coverage at all. As noted, the sad truth of the matter is that fewer than 9 percent of seniors over the age of sixty-five have any sort of long-term care coverage. Premiums for traditional long-term care insurance are soaring, sometimes in excess of 40 percent per year or more.
What's more, many clients refuse to request CPAs to issue a W-2 Form to those whom we're paying for at-home long-term care, thereby eliminating any potential tax breaks they're entitled to along the way. There are also tax breaks for kids footing the bill for parental care, if certain criteria are met. The long-term care issue can't be ignored, but it's going to be one of the toughest nuts to crack for you as a financial professional as you pursue an integrated plan for your clients during the accumulation and distribution phases of their financial lives.
Blunder 7: Playing cheapskate with Medicare supplemental insurance coverage
For clients operating with very limited retirement cash flow, the idea of shelling out close to $5,000 per year for supplemental Medicare and other health coverage really presses a hot button. Clients get angry. They wring their hands and say they can't afford, say, Part D in Medicare to help offset the expenses for prescription drugs. They'll typically go for the cheapest options, namely Medicare Advantage plans, falsely thinking they don't need more than the minimum.
Of course, they're wrong about that! Unexpected increases in health care costs not covered with some form of insurance, including Medicare, represent a financial danger to clients, second only to the ruinous costs of unexpected and unplanned for long-term care. The present state of Medicare and the options open to your clients are complicated even for financial professionals. Imagine what it's like for your clients. They're going to become confused, frustrated, and frequently annoyed about the entire issue. In spite of this, encourage them to make the effort to do all their homework before enrollment time approaches, and to include in the cash flow equation payments for the best possible health care coverage that they can afford. Medicare Supplement plans represent a huge bargain that retirees should buy unless they are financially destitute and forced to rely on Medicaid.
Blunder 8: Falling prey to inevitable inflation
As financial professionals with a passion for economics, we all know that the basics of financial markets always—and I mean always—include inflation in the equation. No matter what goes on, the dollar of today won't have the same purchasing power as the dollar of thirty years hence. While your clients would agree with you, they're much less likely to actually take your advice and plan for inflation as they work with you on their retirement grand plan. It's your job to point out the weakness in a long-term strategy that fails to include inflation pressures that will slowly but surely creep up over time.
(Continues...)
Excerpted from Don't Let Your Clients Eat Dog Food When They're Old! by Roger Roemmich. Copyright © 2014 Roger Roemmich. Excerpted by permission of iUniverse.
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